EU Fund Managers Face Pay Rules in Deal on Anti-Madoff Law

Fund managers will face tougher European Union pay rules as part of a deal on a draft law that also seeks to prevent fraud similar to the Ponzi scheme orchestrated by Bernard Madoff.

European Parliament lawmakers and Greece, which holds the rotating presidency of the EU, agreed on the measures for funds known as UCITS, or Undertakings for Collective Investment in Transferable Securities, today. The toughened pay rules include a ban on guaranteed bonuses and a requirement that payment of at least 40 percent of bonuses be deferred for three years, according to statements from parliament lawmakers.

“Today’s deal will deliver greater protection for investors, as well as taking steps to reduce reckless risk-taking in the investment fund sector,” Sven Giegold, the EU parliament’s lead negotiator on the law, said in an e-mail. “The revised legislation includes important provisions on remuneration that will ensure the interests of investors are better reconciled with those of fund managers.”

European Union legislators have clashed over how far the bloc should go in transferring pay rules for bankers to managers of investment funds. Lawmakers last year rejected a push by Giegold for the bill to include a ban on fund manager bonuses worth more than fixed pay.

Own Shares

While that plan wasn’t taken forward, today’s deal does include a requirement for half of bonuses for UCITS managers to be paid in the fund’s own shares, according to a statement on Giegold’s website. The European Securities and Markets Authority, an EU agency based in Paris, will draft guidelines on which staff should be covered by the pay rules.

“We want to ensure that responsible remuneration policies are in place across the financial sector and that there are no loopholes for risky and dangerous trading practices,” Arlene McCarthy, a legislator in the assembly’s Socialist group, said in an e-mail.

The European Commission, the 28-nation EU’s executive arm, proposed in 2012 to toughen the bloc’s rules for UCITS in order to curtail the risks of Madoff-style fraud. Madoff pleaded guilty in 2009 to orchestrating what prosecutors called the biggest Ponzi scheme in history and is serving a 150-year sentence in U.S. federal prison. The fallout of the fraud included the liquidation of four UCITS funds, a type of retail investment vehicle allowed to operate across the EU.

Fraud Prevention

The new rules, scheduled to apply starting in 2016, will “ensure that the abuses seen at the time of the Madoff scandal cannot be repeated,” Michel Barnier, the EU’s financial services chief, said in a statement.

The accord today still requires approval from the full parliament and national governments to take effect.

Under the draft law, banks and other institutions that act as so-called depositaries for UCITS would face limits on their ability to delegate away responsibility for the safekeeping of assets. The measures also clarify the custodian bank’s liability in the event that assets are misused by fund managers, and firm up rules requiring banks to keep the fund’s asset pool segregated from their own investments.

The Madoff case saw courts in the EU take “different approaches” when deciding whether depositary funds should be held liable in situations where they had delegated responsibilities to other lenders, and assets had been lost, according to the commission.

Lenders that provide safekeeping services for UCITS and other types of assets include Bank of New York Mellon Corp., State Street Corp. and BNP Paribas SA.

BNY Mellon, the world’s largest custody bank, had $25.5 trillion of “client assets under custody” in 2010, according to a report published by the commission.

Other parts of the new rules include that ESMA should set up a secure channel for whistle-blowers to make contact. The draft legislation also sets out sanctions that should be applied when fund managers break EU rules.

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